Australia’s Tax System Under Fire: Economic Rents Fueling Corporate Profits

Economic Rents Drain National Income

Australia’s economy is increasingly dominated by powerful corporations extracting substantial profits beyond normal market returns. These firms are benefiting from “economic rent,” achieved by charging higher prices due to a lack of competition, according to the Productivity Commission (PC).

Key Industries Flagged for Rent Extraction

The PC’s interim recommendations for corporate tax reform highlight the issue of economic rent. Industries identified as major players in rent extraction include gas, oil, coal, iron ore, banking and financial services, wholesale and retail, and telecommunications networks.

Productivity Commission Recommends Tax Shift

The Productivity Commission is advocating for a significant overhaul of Australia’s corporate tax system, urging the Albanese government to target economic rents more aggressively. This approach, supported by economists like Ross Garnaut, aims to address systemic economic weaknesses.

“The Australian economy has performed well compared with comparable countries over the last three decades only if we average the excellent performance in the 1990s and the poor performance over the past decade. Real wages over the past decade have stagnated — to an extent without historical parallel. We cannot understand the economy’s underperformance without recognising the increasing claims of economic rents on national income. Correction of weaknesses requires coordination of many policy instruments including measures to reduce the prevalence of rents (competition policy and regulation of oligopoly where competition is not feasible or inefficient) and changes in taxation arrangements to shift the burden of business taxation from firms in competitive activities to firms relying heavily on economic rents.”

—Ross Garnaut

Garnaut, in his recent analyses, including his 2023 Bannerman Lecture and September 2023 Henry George Commemorative Dinner address, has emphasized the need to reconfigure taxation to capture these rents. His work suggests that national companies’ competitive standing has weakened against multinationals due to tax avoidance opportunities.

A 2020 paper co-authored by Garnaut, Craig Emerson, Reuben Finighan, and Stephen Anthony argued that Australia’s corporate tax framework is outdated for the 21st century. The increased mobility of capital has fostered a global “race to the bottom” in tax rates, while international transactions offer multinationals greater avenues for tax avoidance.

“This paper suggests a major change in approach to taxing corporate income. It proposes changing the corporate tax base, from a conventional view of income to cash flow. This increases the incidence of the tax on economic rent, and reduces the incidence on competitive or ‘normal’ returns on investment. Our proposed cash flow tax is relatively simple to administer, applying familiar and well‐tested measurements of the taxation base.”

—Garnaut and colleagues

Economic Rents Now Dominate Tax Revenue

New modelling by economist Chris Murphy, commissioned by the PC, indicates that economic rents now constitute 54% of Australian corporate tax revenue, a significant increase from 41% in 2016-17. This trend coincides with a decade-long decline in business investment and lackluster productivity growth.

Murphy‘s analysis identifies three primary sources of economic rents: oligopoly rents, mineral rents, and land rents. His findings reveal that a significant portion of oligopoly rents—85%—is concentrated in just five sectors: bank interest margins, wholesale and retail margins, bank fees, and telecommunications networks.

The PC asserts that shifting taxation towards economic rents, which are immobile and do not deter investment, is crucial. Taxing normal returns on capital, conversely, creates a “double disincentive” effect on both investment and labor supply.

In 2023, Australia’s mining sector saw record profits, with the coal industry alone reporting a 77% surge in profits in the year to June 2023, according to the Australian Bureau of Statistics. This highlights the substantial revenue potential from resource rents.

Proposed Tax Reform Targets Large Corporations

The PC’s proposal includes a reduction in the headline company income tax rate to 20% for companies with revenue under $1 billion. However, larger companies with turnover exceeding $1 billion would retain the current 30% rate in the short term. Additionally, a new 5% net cashflow tax on company profits is recommended, designed to incentivize capital expenditure.

This reformed tax system is projected to boost investment by $7.4 billion and GDP by $0.5% over the medium term. The PC believes that by taxing economic rents more heavily, tax burdens can be reduced for millions of smaller Australian businesses, fostering competition and challenging established market leaders.

The Commission points out that complex tax and regulatory systems often hinder new entrants, limiting competition and slowing productivity growth. The current corporate tax system, it concludes, is not delivering optimal economic outcomes.